Does it Make Sense to Take Out a Mortgage for a Tax Deduction?
A lot of property owners right now are considering refinancing their mortgage loans while the home prices are high and the interest rates are low. Check out my article from last week for more information to help you decide if refinancing makes sense for your situation.
Is a Mortgage Worth the Tax Benefits Alone?
Recently, I’ve been talking with a lot of homeowners and investment property owners who are considering taking out a second mortgage or refinancing purely for the tax deduction benefits. In theory, it seems to make sense as a way to shelter other income (say rental earnings) from taxes. You can write off points and obviously take advantage of mortgage interest deductions, especially considering that all mortgages are front-loaded with higher interest payments in the earliest years of the loan.
In most cases, however, taking out a mortgage purely for tax benefits is not a wise solution. It may end up being more of a net loss than a gain by the time you put all the factors together.
How will the Mortgage Proceeds Be Invested?
First, you have to consider how the mortgage proceeds will be invested. If you are paying more on the new mortgage than the rate of return you are getting on the investments you make, then clearly this is a losing scenario.
What is Your Tax Bracket?
Another factor is your tax bracket. Which tax bracket are you currently in and will the ultimately investment earnings put you in a higher bracket? You could actually end up with higher tax liabilities than you started.
A Real-World Example
You are buying a new home and you are looking for a bigger place with a separate suite where your mother-in-law can move in. She still owns her home outright and plans to hold onto it as a rental property. However, her tax advisor recommends she still have a mortgage because it will be better for her taxes to offset some of her rental income.
The options here are for her to take out a second mortgage on her old property or for her to join you as a co-borrower on your new home loan. Ultimately, she would have to run all the numbers to determine if this works. In most cases, the tax savings will not be enough to offset the costs of the new mortgage. There may be scenarios where it does work out in her favor, as well, especially if she is able to put the extra money toward higher-yield investments. The important thing is to do the math and think through every financial decision very carefully.
Understanding All the Ramifications
In general, it never makes sense to take out a mortgage purely for tax reasons. This strategy only works if you have a strong investment plan that provides a net gain opportunity. Otherwise, a mortgage that’s used solely as a tax shelter will usually result in a net loss when all is said and done.
If you are considering refinancing or restructuring your mortgage, it helps to talk with your financial advisor and make the right financial decisions. Illumination Wealth is here to provide you with all the financial advisement services you need to make your money work for you. Contact us today to schedule a no-obligation consultation.